Hamill: The business tax break that smiles back

The July 4 tax bill has received a lot of attention, particularly at the end of the year. Much is written about the effect of this bill on 2025 and 2026 tax returns.

Today, we look at a provision that applies to investments in “C” corporations. This one has existed since 1993, and just like people, it gets better with age.

A corporation is called a “C” corporation or an “S” corporation based on the organization of the tax code.

The tax law is found in Title 26 of the U.S. Code. Subtitle A is titled Income Taxes. Chapter 1 is titled Normal Taxes and Surtaxes.

Within our “normal” taxes, we then have subchapters. Some corporations find all of their rules in subchapter C, hence they are called C corporations.

Other corporations, if eligible, may elect to have certain things instead taxed under subchapter S of chapter 1, hence they are called S corporations.

C corporations may create two levels of tax — one at the corporate level and a second at the shareholder level.

S corporations have only one level of tax — at the shareholder level — unless tainted by some association with a C corporation.

People seem to like one level of tax rather than two. Therefore, almost all corporations that meet the eligibility rules elect to be S corporations.

Tax advisers warn that counting taxes like sugar in a coffee cup — one lump or two — misses important issues.

First, there is a second level of tax owed only if dividends are paid to shareholders or assets are sold and liquidating distributions made to the owners.

If the owners also provide services, loan money or lease property, corporate profits can be distributed with compensation, interest or rent.

Each of those allows a corporate deduction, so the income used to pay the obligation is pre-tax, and only one level of tax is paid by the two parties.

Second, the special tax break of this column, which has existed since 1993, allows C corporation stock to be sold with no tax paid.

The 1993 version did not provide for zero tax on stock sale gains. But the post-2010 version did, and it keeps getting more attractive.

For C corporation stock issued after the July 4 enactment date of the new tax bill, zero tax on gains is available if the C corporation stock is held for three or more years.

The stock must be “small business” stock. But the rejuvenated exclusion allows corporations with $75 million of gross assets to qualify.

The exclusion can now be as large as the greater of $15 million or 10 times the basis of the owners’ stock (it is a per stock issuer limit, not per shareholder).

Let’s say you want to start a business now. The business will be a corporation. You plan for growth and will reinvest all after-tax earnings.

You invest $1 million in exchange for stock. The corporation is wildly successful. Each year it earns a profit. A C corporation would pay a 21% tax rate.

That 21% rate applies no matter how much is earned. S corporation earnings could be taxed as high as 37% at the individual level.

This means that 79% of earnings can be reinvested. The $1 million investment grows to a stock value of $16 million in three years.

You decide to sell the stock of the company. Your gain is $15 million. None of this is taxed. Your gain is within the special exclusion limit.

If you had made an S election, the annual earnings would be taxed at individual tax rates as high as 37%. Stock sale gains would be taxed at 20%.

What if the buyer wanted to purchase assets? The corporation might then be subject to a tax on the gains, but at 21%.

You would then get a liquidating distribution, but the special tax exclusion would shield that gain from a second level of tax.

After the 1986 tax reforms, which prevented C corporations from tax-free liquidations, advisers have pushed investors to S corporations when available.

There’s more to this than one can say in a tax column. But the possible combination of a 21% corporate and a zero shareholder income tax rate is worth considering.